A New Playbook for Diversified Companies
Here’s how strong performers are defying expectations about the demise of the multi-business enterprise.
A wave of corporate breakups has rippled through industry after industry over the past several years. This has happened in consumer goods, for instance, with Kraft Foods’ spin-off of its North American grocery business; in materials, with Alcoa’s split into separate aluminum and engineering businesses; in technology, with HP’s separation of services and software from printers and PCs; in energy, with Danish industrial conglomerate A.P. Moller-Maersk’s divestiture of its oil businesses; and in health care, with Siemens’ spin-off of its medical technology division. The trend started in the 1980s in the United States and reached Europe in the late 1990s, but it has intensified in recent years, as more vocal investors have pressed for more focused business structures.1
You might wonder if we are finally seeing the long-anticipated demise of the diversified public corporation.2 After all, both finance and strategy scholars, while recognizing that a little diversification can be a good thing, have argued for years that greater amounts of it are detrimental to performance and value creation, particularly when businesses in a portfolio aren’t clearly linked.3 This idea that the relationship between diversification and performance follows an inverted U-shaped curve has become established wisdom in management literature.4 It continues to permeate leading textbooks on corporate strategy.5
Why would companies diversify beyond optimal levels? Because, traditional thinking suggests, managers have enjoyed higher compensation levels and faced fewer takeover risks in large, diversified corporations than in smaller, more specialized companies. So, many observers assume that it was in response to greater capital and product market pressures in more liberalized, well-developed economies that companies de-diversified and focused on one or a narrow range of activities that they know best.6
Though this tidy narrative is intuitively appealing, two aspects of it don’t hold up. First, some companies continue to be highly diversified — and do well. Many private equity groups and conglomerates such as Alphabet or the Mahindra Group are thriving in multiple lines of business. This observation resonates with recent research7 suggesting that the capacity to manage diversification differs more widely between companies than previously thought.
1. M. Pooler and P. McGee, “U.S. Hedge Funds Join Chorus for Change at Europe’s Conglomerates,” Financial Times, Aug. 20, 2018.
2. M.C. Jensen, “Eclipse of the Public Corporation,” Harvard Business Review, September-October 1989.
3. J.M. Campa and S. Kedia, “Explaining the Diversification Discount,” The Journal of Finance 57, no. 4 (August 2002): 1,731-1,762; and D.J. Miller, “Firms’ Technological Resources and the Performance Effects of Diversification: A Longitudinal Study,” Strategic Management Journal 25, no. 11 (November 2004): 1,097-1,119.
4. J.R. Pierce and H. Aguinis, “The Too-Much-of-a-Good-Thing Effect in Management,” Journal of Management 39, no. 2 (Feb. 1, 2013): 313-338.
5. M.A. Hitt, R.D. Ireland, and R.E. Hoskisson, “Strategic Management: Competitiveness and Globalization” (Boston: Cengage Learning, 2015).
6. K. Lee, M.W. Peng, and K. Lee, “From Diversification Premium to Diversification Discount During Institutional Transitions,” Journal of World Business 43, no. 1 (2008): 47-65.
7. T.B. Mackey, J.B. Barney, and J.P. Dotson, “Corporate Diversification and the Value of Individual Firms: A Bayesian Approach,” Strategic Management Journal 38, no. 2 (February 2017): 322-341.
8. R.A. D’Aveni, “Choosing Scope Over Focus,” MIT Sloan Management Review 58, no. 4 (summer 2017), 22-26.
9. M. Schommer, A. Richter, and A. Karna, “Does the Diversification-Firm Performance Relationship Change Over Time? A Meta-Analytical Review,” Journal of Management Studies, forthcoming.
10. V. Kuppuswamy and B. Villalonga, “Does Diversification Create Value in the Presence of External Financing Constraints? Evidence From the 2007-2009 Financial Crisis,” Management Science 62, no. 4 (April 2016): 905-1,224.
11. D.J. Teece, “Business Models, Business Strategy, and Innovation,” Long Range Planning 43, no. 2-3 (April 2010): 172-194.
12. A. Karna, A. Richter, and E. Riesenkampff, “Revisiting the Role of the Environment in the Capabilities-Financial Performance Relationship: A Meta-Analysis,” Strategic Management Journal 37, no. 6 (June 2016): 1,154-1,173.
13. Danaher analysis draws on several case studies: J.R. Wells and G. Ellsworth, “Danaher Corporation, 2007-2017,” Harvard Business School Case 717-464 (January 2017); B. Anand, D.J. Collis, and S. Hood, “Danaher Corporation,” Harvard Business School Case 708-445 (February 2008); and L.J. Bourgeois III and S. Nadathur, “Danaher — The Making of a Conglomerate,” Case BP-0549 (March 31, 2010), Darden Business Publishing.
14. A. Campbell, M. Goold, and M. Alexander, “Corporate Strategy: The Quest for Parenting Advantage,” Harvard Business Review 73, no. 2 (March-April 1995).
15. M. Krühler, U. Pidun, and H. Rubner, “How to Be a Good Corporate Parent,” Boston Consulting Group, March 22, 2012.
16. U. Pidun and S. Stange, “The Art of Capital Allocation,” Boston Consulting Group, March 27, 2017.